Chinese textile mill buyers, merchants learning as they go

How do you sell cotton in a country that has nearly doubled its textile mill capacity in the last five years and buys many of its bales only two to three months or even two to three weeks before it opens them?

Very carefully, says Dale Cougot, a former specialist with USDA's Foreign Agricultural Service who now analyzes international market conditions, including supply/demand, price trends and forecasts for Paul Reinhart, Inc., in Dallas.

Cougot, a speaker during the Cotton and Fibers session at USDA's annual Agricultural Outlook Forum in Arlington, Va., says those who have grown up in the U.S. cotton industry may find it difficult to compare the situation here with China's.

“This is especially true in regards to the United States where we have 10 large to midsize spinners at most where in China it is estimated they have more than 5,000 spinners operating 70 million spindles,” he said. “A large portion of the mills are fully integrated. They focus on each part of the textile business and manage them as separate profit centers.”

Cougot, a member of the National Cotton Council's 2004-05 Cotton Leadership Class, says his experience with Reinhart only goes back five years, but he's been able to draw on a combined 220 years of experience at the Dallas office of the Swiss-based Paul Reinhart Group.

“My first lesson after I joined Paul Reinhart,” he said, “was that China is the biggest player in the world cotton market, that it is a country with some of the most astute traders in the world and that no one knows the precise Chinese data.”

One thing that is known is that the world of cotton marketing has changed dramatically since China decided to begin investing in its textile industry in advance of the removal of worldwide textile import quotas. World trade, which had been stagnating at 30 million bales in the 1990s, increased by about 15 million bales between 2000 and 2005.

Meanwhile, China's cotton consumption, which had been hovering around 20 million bales annually, steadily advanced from 23.5 million bales in 2000-01 to an estimated 45 million in 2005-06. “From another perspective, China represented about 25 percent of world consumption, but is now over 39 percent.

“During this same period, China was in the process of privatizing parts of its state-owned businesses,” he noted. “Foreign and local asset investment started supporting the whole gamut of the textile industry. And now they have money for new capital investments and, more importantly, working capital to purchase cotton.”

Chinese cotton yields, which reportedly are some of the highest in the world, appear to have peaked at about 1,100 pounds per acre in 2002-03 before growers began experiencing declines due to inferior weather.

Production had been running around 20 million bales annually during the 1990s, but, over the last five years, China's crop has risen to an average of 24.9 million bales with recent trends pointing at 30 million bales per year.

Cougot says the 1999-20000 season may have been a turning point. “China actually started the year exporting some of their stocks and then experienced bad weather. Some farmers abandoned acreage, resulting in the lowest harvested area over a decade,” he said.

“Harvested acres were back on the rise until last year when a government policy to promote feed grains diverted acreage. Early indications are that planted acres will be up slightly in 2006-07, but still below the burgeoning demand.”

China's stocks situation has also changed, dropping from a peak of 26.3 million bales in 1998-99 to an estimated 12.2 million bales for the 2005-06 marketing year (August-July).

“During this same time, net international trade in any one year did not swing more than 4 million bales until 2003-04,” he said. “Production and the drawdown of strategic stocks were still not enough to meet the fast pace demand which now required substantial imports.

“Also, China was in the process of WTO negotiations to gain access to textile import quotas. Trading partners seeing the potential demand required China to open its borders to a set minimum import quota of 894,000 bales annually. This number seems small today, but negotiators are forced to used past trends to set limits and not future potential.”

Since the peak stocks year of 1998-99, China has allowed its stocks per month of consumption to dwindle from 16 months to a range of two to three months. “Mills were used to carrying stocks of three to four months of consumption to ensure consistent spinning due to quality or transportation issues. Some mills may now carry stocks as low as two to three weeks.”

Cougot didn't speculate on the size of U.S. exports to China other than to note that the weak U.S. dollar and a large U.S. supply have helped the United States account for about 50 percent of China's purchases.

“Exporters of U.S. cotton have retained their principal share of the market in calendar 2005 at 47 percent, although it is slipping from 55 percent last year,” he said. “In the future, it may lose further ground to Central Asia and West Africa growths.”

Another factor often overlooked in the Chinese textile picture is the dramatic increase in polyester capacity. Some estimates say Chinese companies have added the equivalent of 25 million bales of cotton to its polyester sector in the last six years. “Chemical fiber output in calendar year 2005 amounted to 74.8-million-bale equivalents,” he said.

Back on the cotton side, purchasing decisions which had been mainly through state reserves prior to the surge in textile mill output have been passed to individual mills.

“Mill owners and buyers are quickly learning the way international growths of cotton are priced and what may affect their pricing,” he says. “Most of the aggressive mills in China have someone who works through the cotton trading hours of the New York Board of Trade.”

They have learned some hard lessons, which have turned them to buying cotton hand-to-mouth. Among those: Prices can continue to fall even further after dropping 10 cents, 20 cents, 30 cents and more as they went from 84.80 cents in October 2003 to 42 cents in August 2004.

“Many mills kept thinking they were buying at a great level at 65.00 cents, then at 55.00 cents, and, as the market kept falling, they kept buying, averaging down prices buying out six months, then expanding to a year, only to watch the market fall lower,” Cougot said.

“It was also a lesson the international merchants had to work through as they were thinking that these mills had great potential. However, walking away from high-priced contracts was a large issue and hurt many U.S. merchants who were trying to build their international business in China.”

The resulting hand-to-mouth buying is being driven by both sides, he said. “Buyers are limited on credit and scared prices could drop, while international merchants want to limit their exposure and risk as well.”

Buying techniques are changing as international merchants are teaching strategies to reduce the risks on both sides. “However, mills need to make sure they know and trust the merchant they are doing business with to ensure that they are creating strategies that truly reduce price risk,” says Cougot.

Some merchants are selling cotton “on-call” New York cotton futures versus a fixed price. The practice allows mills to lock all aspects of the contract, including the basis, except for the final price. Then mill buyers can placed “good till canceled” orders to try to better manage New York futures or may give a buy order for a fixed price contract using a GTC.

Cougot says Chinese spinners seem to be testing multiple growths to ensure they are not tied to one type of cotton. The latter is a sign of experience as they have seen large quality shifts in their local production.

“This will give them more options to gain a better price in their mixes, but they have also learned an old lesson — ‘you get what you pay for,’” he said. “Buyers have changed their minds from being very quality minded to widening their view to a more balanced approach of fair price and quality.”